Ahead of the Curve

The lending environment is undergoing a worrying change. Funds that European direct lenders have raised but not yet deployed are at an all-time high and banks in most Western-European jurisdictions have renewed lending following years of reticence after the global financial crisis, leading to increased competition amongst lenders in the small and medium enterprise (SME) market.

Rand in 'seriously cheap' zone

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Although there is no link between general Emerging Market Bond Index (EMBI) spreads and the South African rand, there seems to be a strangely close correlation between the currency and Argentina’s debt spreads. “This is tricky to explain,” says Jos Gerson of Merrill Lynch in Johannesburg. “I don’t know if there is a profound explanation but I am convinced that it would not be based on economics. I have been talking with our guys in New York and they deny that there is much Argentina/rand pair trading. Here in Johannesburg our people suggest that yes, maybe some emerging market funds are shorting the rand to cover their losses in Argentina. Before October, these funds were able to short the Brazilian real, but legislative changes put a stop to this, so perhaps they did turn their sights to the rand.” Gerson points out that until the end of September 2001 the rand had been trading according to economic fundamentals. “For the past 20 years, there has been a loose correlation between the rand and the Australian dollar, related to the prices of industrial commodities. Some time during the middle of 1999 this relationship became much closer and the two currencies traded very closely until July 2001. Then, several things happened: the situation in Zimbabwe deteriorated, Argentina’s problems began to escalate and the platinum group metals’ prices collapsed.”South Africa’s economy is essentially energy neutral, explains Gerson, with oil imports offsetting coal exports. But most of South Africa’s exports are commodities or quasi-commodities, and declining commodity prices do have a profound effect on the economy and the currency. Gerson argues that the rand’s depreciation over the 18 months to the end of July may be explained by the fall in commodity prices. The rapid decline which began towards the end of November last year was too precipitous to be explained purely with reference to declining commodities’ prices, he argues. South Africa’s ‘bad points’, including the lack of fixed direct investment, pent-up demand for offshore assets and even the AIDS story, have been acknowledged for years and would, according to Gerson, also be unlikely candidates to spark a selling spree.At the end of November, the rand’s decline speeded up dramatically. “It had the hallmarks of a typical currency crisis,” says Investec Asset Management’s John Stopford. “Conditions deteriorate and the speed of decline increases until it turns exponential. And when it’s done that, at least you know that the end is close in terms of time, if not level.”Cape Town-based Stopford agrees that South Africa’s economic fundamentals, although poor, were not worsening rapidly enough for anyone to have predicted a run on the currency. He suggests that the recent poor liquidity of the rand may explain much of the decline as even a small imbalance in flows would have a very marked impact on the price.Gerson says: “The closeness of the trading does suggest to me that there has been some sort of weird link and my guess is that it was indeed of a trading nature and as such will not endure, but it may never be explained fully. ”Both Gerson and Stopford agree that the mysterious goings on in the FX market have pushed the rand into seriously cheap territory. Stopford states,“The currency is now very cheap. The South African Reserve Bank continues to be internationally respected, the banks are well-capitalised and well-run, as is the South African business sector in general. And the deficit is small But the authorities clearly need to increase the perception that investing in the rand can be a two-way bet.”